Theory and reality

My hypothesis is that the transformation of the property regime in Croatia fits into the neoclassical understanding how a market economy emerges and how it works, while the process in Slovenia looks as if the insights of the economics of property rights were taken into account. In regard to this hypothesis and to the relationship between theory and the real institutional changes I would like to remind on the issues that were already mentioned above: (1) Neoclassical economics explains how a market economy works, while the economics of property rights was mainly concerned with the development (evolution) of economic systems. (2) While property rights economics is mainly a descriptive theory of institutional changes, neoclassical doctrine is frequently used as a normative theory. (3) Property rights economics is not yet capable of creating a consistent and comprehensive policy proposals concerning institutional change (North 1993). These points initiate the following questions:

- If neoclassical economics only explains how a market economy works and not how it develops, how could it be that institutional change in Croatia fits the neoclassical framework?

- If property rights economics is a descriptive theory which is not capable of creating a consistent policy of institutional change, how could it be that the Slovenian privatisation looks as if property rights economics was taken into account?

2.4.1 Normative and descriptive theory

I will start with the point (1) that neoclassical economics is concerned with the operation of markets, not with how markets develop. Privatisation, however, is to be understood as a case of the development of the property regime; as an example of institutional change; it is much more than a mere redistribution of assets. Therefore, according to North (1993), neoclassical economics is an inappropriate tool to prescribe policies for institutional change.On the other side, a theory of economic dynamics based on the economics of property rights comparable in precision to general equilibrium theory and capable of creating a consistent and comprehensive policy proposals concerning institutional change, doesn’t exist. New institutional economics, which stems from the initial analysis of the economics of property rights, provides only

the initial scaffolding of an analytical framework capable of increasing our understanding of the historical evolution of economies and a necessarily

crude guide to policy in the ongoing task of improving the economic performance of economies (North, 1993).

Since a full analytical framework, which would be the basis of a policy of institutional change, doesn’t exist, therefore – concludes North – a theory based on the economics of property rights can as yet only describe the characteristics of past economies, examine the performance of economies at various times and compare different institutional arrangements. In other words, as far as the evolution of economies is an issue, theory can only try to understand it, not to shape it confidently.

It is time to recall the two quotes from the beginning of this chapter. By its nature the Croatian quote is clearly prescriptive (normative). It states what should be done and what would be the consequences: When private property is established one may expect that assets would come into the most efficient hands, regardless of the institutional framework. The normative use of neoclassical economics relies on its presumed predictive power. The Slovenian quote doesn’t provide an alternative plan; it only expresses scepticism towards the neoclassical program, and its view that the establishment of market institutions (among them private property) by decree would necessarily induce the emergence of a market economy. According to the Slovenian quote there were circumstances and effects that were neglected by neoclassical economics and that should have been taken into account if the development of a market economy was to take place: inherited economic culture, people’s expectation, their confidence that the system would work etc. This illustrates the distinction between the two theories: the normative use of neoclassical economics and the descriptive character of the economics of property rights. The Slovenian quote, which emphasises the impossibility of the establishment of the market economy by decree, implies: Neither a comprehensive and consistent theory of institutional change nor an efficient political authority guarantee a successful establishment of the market economy. It requires more: people’s confidence that the system will work.

This brings us back to the role of theory in the problem of economic development. Theory matters, even if it does not generate a defined policy.Theories – the same is true of ideologies and beliefs – represent mental models that individuals and societies create to structure the disorder of the outside world and to cope with challenges and uncertainties (Denzau & North 1994). Even if they do not produce policies theories create expectations about future developments and influence the activity of participants. It will be argued that the continuous discussion

and scientific observation of the process was a characteristic of Slovenian privatisation. In my opinion, this explanation provides the answer to the second abovementioned question: how it could be that the process of privatisation in Slovenia followed the economics of property rights that was not capable of producing policy prescriptions. That is, even without the capability to create a comprehensive policy, a descriptive theory may have practical value.8

2.4.2 Unintended consequences

The first question challenged the hypothesis that institutional change in Croatia fits the neoclassical paradigm though neoclassical economics mainly analyses how a market economy works and only implicitly assumes how it emerged. Nevertheless, it is possible to create a program for the establishment of a market economy based on the neoclassical understanding how market economy works. But a policy of institutional change that relies on a neoclassical understanding might produce unintended consequences. To show that this was the case is exactly the subject of this research: namely, to test the claim of the economics of property rights, that the path of institutional changes that follows neoclassical economics might (or even must) produce failures (unintended consequences) because neoclassical economics does not understand how economies develop, rather, understanding only how a market economy works.

An example could be illuminating. I argue that privatisation in Croatia in fact took the form of an initial appropriation of assets; an unforseen consequence of this approach was that resources were dissipated instead of leading to an increase in the efficiency of the use of resources. Contrary to the neoclassical scenario, which predicted that the allocation of resources to private individuals would initiate the development of a functioning market economy, it didn’t happen. Summing up: the policy of privatisation in Croatia was based on the neoclassical understanding of the development of a market economy, but it produced unintended consequences, because important features, which were emphasised by property rights theory, weren’t taken into account. This is the answer to the first abovementioned question: since the program of institutional changes in Croatia was based on an understanding how a market

8 _{For detailed discussion about the distinction between descriptive and normative economics}

see Subroto Roy (1989). Also I would like to mention an excellent discussion about the implicitly normative character of “a competitive model” (i.e. general equilibrium) in first section of Kenneth J. Arrow’s famous article “Uncertainty and the Welfare Economics of Medical Care” (Arrow, 1963, pp. 941-948)

economy works and not how a market economy develops it produced unforseen consequences9_.

It should be obvious that I am not engaged here in a substantial criticism of neoclassical economics10_{. I will not discuss whether a development of the economics}

of property rights (and the related approach of new institutional economics), which stems from the criticism of neoclassical economics, represents a mere improvement of the neoclassical framework, or if this development forms a totally new economic paradigm. Even the strongest critics of neoclassical economics recognize that this framework may be analytically valuable. The criticism includes the view that a neoclassical framework does not capture the growth and evolution of economic systems. Using the insights that were developed within the property rights economics I describe the transformation of the property regime in Croatia and Slovenia and analyse the shortcomings of the program of privatisation that was based on neoclassical framework. I expect that a description of the processes of privatisation in Croatia and Slovenia, which forms the largest part of this work, may shed new light on the discussion between the two competing theories.